11 February 2021
When you make caramel you wouldn’t normally think to add salt? But adding a little salt really helps to enhance the flavour! I believe this analogy applies to implementing a real assets strategy: blending listed with unlisted investments has the same effect.
Real asset investment means ‘owning’ the tangible asset: the ‘bricks & mortar’ office or toll road. In practice unlisted funds take private (equity) stakes in properties, or infrastructure businesses, and earn returns by collecting income and managing the office or toll road successfully. This is the typical investment approach taken by many long-term investors. But in many ways listed investments – publicly-owned companies whose success is determined by how well they manage properties or infrastructure – are no different. Historical evidence suggests that returns over real asset cycles are also quite similar. For example, since 2009 listed infrastructure returns of 9% pa compare to unlisted returns of 8% pa.
There is however a trade-off when comparing the two. Unlisted investments are valued infrequently, which helps to smooth returns but means they are illiquid. Listed investments, which are valued daily, offer much more liquidity but over the short-term exhibit higher volatility and equity correlation. Yield expectations, sector allocations and capital structure are also very different.
In my view, rather than a simple binary choice of one or the other, why not make the most of their differences by pairing them together: you can have your cake and eat it.
We have compared the risk and return characteristics of a 30:70 blend of listed and unlisted with a pure unlisted and listed approach in the chart below. The chart plots returns on the vertical axis and risk on the horizontal axis. The chart below demonstrates the stark difference in the risk characteristics between unlisted and listed funds with listed funds higher up on the risk spectrum. Generally listed funds will also have a higher return relative to unlisted funds. This means a blended approach could result in a portfolio with higher returns for limited additional risk, as shown by the infrastructure returns below. Whilst the same has been demonstrated for property funds historically, the 2020 pandemic has had a large impact on listed property fund valuations and we have seen performance fall short of their unlisted counterparts. As a result the global property blend returns are a little lower with more risk relative to unlisted global property over the last 5 years.
Source: Investment managers, Bloomberg
So, if blending doesn’t compromise returns and risk for a long-term investor, what are the benefits?
Diversification through the cycle
During market crises listed and unlisted investments respond differently. Listed valuations react swiftly and severely – often short-term market sentiment can mean an over-reaction. As a result, listed investments often recover more quickly. Unlisted valuations, which are appraisal-based, tend to lag listed with a smoother trajectory and a lower peak to trough. These differences are illustrated below during the 2007-9 financial crisis.
Source: LCP. US property (Invesco fund returns), listed property (FTSE Nareit All Equity REITs Index, less withholding tax), unlisted infrastructure (average of IFM and JPM fund returns), listed infrastructure (FTSE 50:50 Global Core Infrastructure Index).
Blending the two allows portfolios to benefit from valuation differences through the cycle; particularly if listed positions are re-balanced after a market dislocation to exploit any mis-pricing. Now may be a good time to top up your existing real assets allocation with an investment in listed real assets - allowing you to take advantage of the more pronounced sell-off during the 2020 pandemic. For long-term investors, exposure to different 'patterns’ of returns can also reduce portfolio risk.
Variety is the spice of life
Listed real assets offer exposure to opportunities in different assets or sectors unavailable to many unlisted funds.
Traditional UK property funds are biased toward office and retail sectors, whereas listed funds have a global focus, and higher weightings to alternative sectors more in step with demographic trends eg residential.
Listed infrastructure – with more in power generation and communications, less in transport and utilities - has a different flavour to unlisted. Listed also provides more opportunities in nascent sectors like data centres, renewables or life sciences.
Using an active approach in listed allows good managers to skew the portfolio to the most attractive sectors (something that is harder to do quickly in unlisted).
Subscription queues for unlisted fund can mean an 18-24 month wait to invest. This means you could miss out on returns, especially in a recovering market. Using listed investments as a stop-gap while waiting to draw down an unlisted fund helps mitigate out-of-market exposure, particularly if listed will be blended into a long-term allocation anyway.
Rebalancing strategic real asset allocations is also easier if listed is a component; this, together with scope to take advantage of mis-pricing opportunities, is a material advantage of using a blend.
Listed strategies generally have lower fees, no performance fees and minimal entry costs. Over the long term, combining listed with unlisted is a great way to keep costs down.
Some food for thought
Blending listed with unlisted is not new. Large institutional investors, like sovereign wealth funds, employ this strategy to augment and manage liquidity for perpetual real asset allocations. The pandemic has impacted property and infrastructure markets materially, but I believe this opens up investment opportunities for long-term investors in 2021 and beyond. It is a good time to consider topping up your allocations to unlisted property or infrastructure, and if this is on the table for your portfolio, a listed allocation can be a part of the ‘real assets’ pie.